The Alibaba IPO-The Good, The Bad and The Ugly by D. R. Barton, Jr.
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The Alibaba IPO:
The Good, The Bad and The Ugly
The article title today aptly references the awesome Spaghetti Western movie starring Clint Eastwood. The musical theme for “The Good, The Bad and the Ugly” is one of the most iconic and enduring ever made. That two-note warble has entrenched itself in popular culture as synonymous with a pending stand-off.
While the Alibaba IPO didn’t necessarily seem like a gunfight, the tension leading up to opening trade was pretty unique. Then on Friday, the atmosphere of tightly-wound anticipation quickly changed to a carnival-like atmosphere on CNBC with the flurry of trading - more than a quarter-billion Alibaba shares changed hands.
This IPO had something for everyone. Let’s take a look at Alibaba the company, its unique structure, and whether it’s a place where you should think about investing.
Alibaba – The Good
First of all, what the heck is Alibaba? Really, it’s a conglomeration of ecommerce platforms similar to a combination of Amazon, Ebay, Paypal and even Google search all rolled into one – only a whole bunch bigger. Throw in a bank and a business-to-business commerce platform and you have an online juggernaut with the lion’s share of the biggest growing ecommerce market – China. Does an 80% market share sound interesting to anyone?
What has been the key metric for this company’s offering? The huge amount of money Alibaba already makes. Its sites sold $298 billion in goods in 2013, generating $8.5 billion in revenue and quite frankly, the margins are stunning. While Ebay manages a healthy 18.1% net profit margin, Alibaba Group’s number was a whopping 48.4% for 2Q 2014 according to the Wall Street Journal. That’s more than double Apple’s 21.9% and is one of the main reasons that Alibaba was able to grab such a monstrous valuation. With margins that high, the company can afford to compete (read – cut prices) with competitors that have much lower margins.
Also on the good side – this was the biggest IPO – EVER. Under the initial terms, folks had to say biggest “U.S. based” IPO because the Hong Kong based IPO for the Agriculture Bank of China in 2010 at $22.1 billion was $0.3 billion bigger. That was the case until… Alibaba’s investment bankers exercised the “green shoe” option, buying an extra $3.8 billion in shares from the company and taking the total IPO value up to a world record $25 billion.
The term “green shoe” option refers to an over allotment option that was coined in homage to the original over allotment exercise for the Green Shoe Manufacturing Company in 1963. The name for the IPO mechanism stuck even if the shoe company’s name didn’t - which eventually became more recognizable to us today as the Stride Rite Corporation.
The IPO size is just one of the “big” numbers for Alibaba. On Friday (the day of the IPO), Alibaba debuted as the 19th largest publicly traded entity (by market cap) and the fourth largest tech company. Who’s bigger? Only Apple, Google and Microsoft. Not bad for a company formed just 15 years ago.
And I can’t leave the “good” section of Alibaba without commenting on the quirky, unique personality at the head of the company, Jack Ma. After watching him for years prior to the IPO, I must say that he seems to embrace sincerely the six core values of his company:
- Customer first
- Embrace Change
He comes across as truly being himself and not getting caught up in all the media hype. No matter how the CNBC staff tried to slice and dice their questions to him, he seemed sincere and genuine in sticking to who he is. When asked on the morning of the IPO who his hero is, he said, “Forrest Gump”. This brought an incredulous, “You know he’s a fictional character, right?” from an anchor desk. Without missing a beat, Ma explained that he loved how Forrest was always exactly himself no matter how bad things got – or how good. That’s kinda’ cool, actually.
Alibaba – The Bad
If you go out and read the risk factors for Alibaba, most of the articles you’ll find talk about traditional factors like China growth risks (if it slows, Alibaba will feel the effects), the company’s ability to improve their thrust into mobile commerce, the high stock valuation, etc.
But this conventional analysis misses the biggest risk factor for purchases of Alibaba shares on the NYSE: the shares of Alibaba are not common stock. They represent no actual ownership in the underlying company. Instead, Alibaba shareowners get Variable Interest Entity (VIE) shares in a company domiciled in the Cayman Islands. In simple terms, shareholders have bought into a structure that has a contract with Alibaba for revenue rights instead of ownership rights.
VIE is quite different than the more commonly used ADR (American Depository Receipt) structure for foreign company share offerings in the U.S. Household names like Sony, Toyota, and Royal Dutch Shell are traded in the U.S. using ADRs. For an ADR, a U.S. financial institution holds the actual shares in overseas accounts for the owner’s benefit but with an ADR, you really do own stock in the company.
Alibaba used the unusual VIE structure because the Chinese government doesn’t allow foreign investment in Chinese-based internet companies. In the long run, this could be a very big risk factor for Alibaba “shareholders”. The Chinese government currently allows VIE structures so that large amounts of foreign capital can fund its companies. Current Chinese law, however, already provides the Chinese government a path to void VIE contracts if it so desired in the future.
According to the Wall Street Journal, this risk factor is very real:
A memo from the law firm Robins Kaplan Miller & Ciresi LLP cited a clause in China’s contract law that declares a contract void “when a lawful form is used to conceal an unlawful purpose” and continues, “The whole VIE structure thus appears to violate Chinese law to the extent its main purpose is to conceal foreign investment in forbidden sectors.”
The Alibaba prospectus clearly concedes that the structure may be illegal in China, stating that “the [Peoples' Republic of China] government may not agree that these arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future.”
It’s also important to keep this risk factor in perspective. The actual probability that the Chinese government would crack down on the use of VIE structures is very low. There are a large number of Chinese internet companies that have benefited greatly and grown fast thanks to having access to global capital markets. And the Chinese government doesn’t want to put that continued growth in jeopardy. If global relationships grew contentious, however, or if a radically different regime came into power, this potential card could be played.
Alibaba – The Ugly
Overall, I actually like the story of Alibaba. It is the first mover in China’s massive ecommerce business and is perhaps the only legitimate near-term contender to turn the big five tech world-beaters (Apple, Google, Facebook, Amazon and Microsoft) into the big six.
With that said, I don’t like the current price levels and think that savvy investors who are patient will have the opportunity to add some Alibaba to their portfolios at significantly better prices. This was certainly the case in two recent ultra-high profile IPOs:
Facebook is a true runaway winner, having tripled in the last 14 months but it dropped almost 60% within four months of its IPO.
Twitter has not quite found its footing yet and has certainly offered multiple chances to buy it on pullbacks.
In short, a portion of your portfolio could benefit from the long-term prospects of Alibaba. But there’s a good probability that patient money can find a better price in the coming months.
Lastly, much has been written about the possibility about the size and number of IPOs that have hit the markets in the last 18+ months. In our next article, we’ll take a look at whether the IPO landscape is pointing toward an equity bubble. Until then…
I’d love to hear your thoughts and feedback about Alibaba AND any thoughts on start-ups built around cyber currency and /or blockchain adoption. Just send an email to drbarton “at” vantharp.com.
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Applied to Trading
A Report From Van Tharp
One of my Super Traders is a professional trader who recently finished ST1. He has been applying what he learned in ST1 to his trading including; 1) a willingness to do a feeling release on anything that comes up (see Chapter 8 of Trading Beyond the Matrix) and 2) following his Inner Guidance or as he calls it, his Higher Power (see Chapter 10 of Trading Beyond the Matrix).
The following is an example of what he went through in one week last month. I’m sharing his experience so you realize you don’t have to go through the Super Trader program to transform yourself. Anyone who reads Trading Beyond the Matrix has enough information to improve their trading through this type of transformational work.—V.T.
The releasing I did this week was the most intense I have experienced thus far. It was very rewarding but it scared the sh** out of me. Again the fight-flight kicked in as I put trades on, and instead of resisting it, I allowed myself to fully experience it as much as I could. My Higher Power (HP) was guiding and encouraging me to stick with it, and in the back of my head I was reminded of how Van commented that most people would run when it got really tough. It got tough and I really wanted to run.
One of my trading rules says that I can follow the advice of my HP. Thus, on Tuesday, my HP encouraged me to put a trade on earlier than my rules which resulted in a 1R loser and being down on the week. This led to another day of intense fight-flight feelings and releasing those. His guiding me to a loser crushed me and had me feeling depressed, full of doubt, frustrated though HP kept telling me to stick with Him and Trust and Surrender.
Later in the day He then encouraged me to take a trade that I would need to carry overnight in the same product. As you may imagine, I was scratching my head though I trusted and put the trade on hoping the lesson would come later as it usually does.
That night during a meditation class, another miracle happened. It became clear to me that I was teetering with 100% Trust, though I had never crossed the line and gone all-in. It was clear to me that I needed to cross the chasm, commit and stop “dancing” with it. It will require quite a bit, including releasing any parts or beliefs that have doubts.
My night was restless, though my HP kept repeating to fully Trust and that He has always taken care of me. He wanted me to stop worrying about the short-term. Let go of attachments and Trust he will make things work. By the time I arrived at my desk the next morning ready for trading that day, I was rather relaxed and stopped checking prices every few minutes. I understood He would guide me, and do what was in my best interest. I was having fun trading and had a big winner on the open trade which put me up for the week!
On Thursday, fear started to kick back in, and I was terrified to start trading. It was as if a bully was waiting for me. Later in that day my HP encouraged me to put on a trade at somewhat of a small size. As I put the trade on, my fight-flight kicked in so intensely that I thought I was going to pass out. I found this strange knowing I had only a small position so I stuck with it. The feeling kept getting stronger and at a certain point, it could not get any stronger. At this point I knew I had conquered the fear and started laughing. It became clear that if I could fully allow myself to experience fears, I could conquer them. This experience took all my courage because I felt I would pass out or have health repercussions from fully feeling those feelings, however, I knew my HP was guiding me. I was trembling, my hands were freezing and I was scared sh**less. The intensity was extremely high, but the reward to confront and overcome my biggest fears was worth it.
I cannot emphasize how scary yet rewarding this was. Each day of doing this, I am feeling clearer. I kept asking my HP if I needed to continue, because I am scared and because I don’t want to torture myself. He affirmed I was releasing and not torturing myself for no reason. The more I released, the more I can handle.
My Security part has been fearful of running out of money, being alone, not having food, etc. and it has not been fully on board with all of the releasing. My HP informed me I was scared from my post college experience which I will look into. My Security part was willing to get on-board if HP would help release its fears. HP informed that would take longer than a few weeks, because those fears are deep and cannot come up all at once without hurting me. He reminded me he will not present me with anything I cannot handle and that the clearing will be a ride, that swings will be extreme, but also that the highs will keep getting higher. I asked, “Why does it have to be so painful?” His reply was, “It’s the fastest way to learn.” Although I have face-planted over and over again, it feels as if I am growing stronger with each fall and that I am almost over the hump.
The bottom line is that I now realize I have been fearful my entire trading career but I tended to suppress the feelings and escape. Thus, I had no idea what type of hell I was living in trading until I started releasing. I will always remember how hard this has been. I’ll do my best to understand how difficult this process can be for others and the reason so many of us run from our biggest fears.
As the fear in my head quiets, I am starting to see more clearly. This week I was seeing the markets much clearer than ever before which was fun and it has been interesting to notice how my feelings / mood manifest in my trades. It will be fun to live in heaven on earth again and to start having Fun trading all the time!
The journey continues to be interesting. Some days I feel on top of the world, others I feel depressed, but the change is happening faster than ever. I have no doubt I am too attached to the results I desire trading. As I fully Trust, I will be able to Surrender to my Higher Power what is best for me.
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